Have the Securities Laws Been Over-criminalized?, Contributed by Joan E. McKown, Jones Day

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Last month this column suggested that, in light of its likely budget shortfall, the Securities and Exchange Commission (SEC) should rethink where its Enforcement resources are focused. While Democrats in Congress have proposed a budget increase for the agency, that effort is likely to fail and become entangled in wrangling over implementation of the recent Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). Therefore, the agency must aggressively rethink what it can and cannot achieve with the resources it has received. In answering that question the SEC needs to ask whether there is some other agency that could cover a particular area. I previously suggested that the SEC’s expertise is not needed in the area of Ponzi schemes, which any criminal agency could prosecute. Beyond that, however, is there more of the world that could be divided up between the SEC and criminal law enforcement?

There are times that the SEC, a civil law enforcement agency, needs the help of criminal law enforcement. Largely this occurs when a matter involves (1) a recidivist defendant who has repeatedly violated the law; (2) egregious misconduct, for example when a broker misappropriates investors’ money; and (3) perjury or obstruction of justice in an SEC investigation. Previously, the SEC had to work hard to get the U.S. Department of Justice (DOJ) and U.S. Attorneys’ Offices, at least outside the Southern District of New York, interested in its matters. After Enron, this changed. In the wake of that scandal and all the reported financial frauds of that timeframe, former President George W. Bush spoke at a meeting of various federal law enforcement agencies and told them he wanted white collar crime to be a priority. From that point on, the relationship between the SEC and the various U.S. Attorneys’ Offices became much more effective and there was a much greater interest in working together in these matters. But, has the pendulum now swung too far in the opposite direction?

By simultaneously filing many of its biggest cases with the criminal authorities, sometimes, when the SEC files on its own, little attention is paid to the matter. Possibly the press and the public have become conditioned to viewing a case as less significant when the SEC files it alone. As a result, many commentators have questioned why criminal cases have not been filed that stem from the financial crisis. It’s possible that no crimes were committed. Not every bad thing, including the financial crisis, is a criminal violation of the law. Certain conduct involved in the financial crisis might be distasteful to some, and even morally wrong, but whether it is a violation of the law can be a difficult and complex question. In part, Congress passed Dodd-Frank for this very reason. Dodd-Frank addresses the lack of transparency of OTC derivatives activity, increases capital requirements for broker-dealers, and requires regulation of external business conduct by swap dealers. Some commentators also totally overlook the many cases brought by the SEC related to the financial crisis. These were all big cases, just not criminal cases. While a small number of the SEC’s financial crisis cases received considerable press attention, most of the agency’s other financial crisis enforcement actions, which they list on their website, received considerably less.

One problem is that when the SEC files a case at the same time as the criminal authorities, it is often overshadowed and receives little attention. For somewhat obvious reasons the agency that can throw a person in jail receives the headlines and the press when the SEC and DOJ file simultaneous cases. In virtually all of these cases the criminal case is tried first, and in fact if the judge won’t stay the civil matter the SEC often seeks to have it voluntarily dismissed. This lack of attention is a problem for the SEC since filing any case requires enforcement resources. The agency should get attention to be perceived as a credible threat to potential violators of the law as an effective enforcement agency. The SEC contributed considerable resources investigating the Galleon Management, LP and related insider trading cases and filed cases often on the same day as the U.S. Attorney’s Office. Yet many well-informed individuals asked why the SEC wasn’t bringing these cases. The SEC was simply overshadowed and received little of the credit it deserved.

Another problem with filing simultaneous cases occurs when the criminal authorities lose their case. The criminal authorities may have a hard time convincing the jury that the evidence meets the criminal standard of “beyond a reasonable doubt.” It is very possible that given the lower civil standard—“by a preponderance of the evidence”—and without the threat of jail time, the jury would have otherwise found the defendant at fault. But once a defendant is acquitted in the criminal case, it is very difficult for the SEC to proceed with a civil enforcement action. Of course this can mean that a person who should be enjoined from future violations of the law, barred from being an officer or director, ordered to pay disgorgement or a penalty, but who doesn’t deserve jail time, may get off completely. Not to mention, the resources that the SEC invested in investigating the matter will go to waste.

Should the SEC be focusing its attention on matters that are more technical and clearly not criminal? It is of course somewhat difficult to split up the world with another agency. But, more of the coordination between agencies should mean dividing up the work rather than simply filing cases at the same time with the same underlying facts. There are many violations of the law which require, and could highlight, the SEC’s expertise. Certainly those involving structured products, corporate financial fraud, the new regulations regarding swaps and ever increasingly complex insider trading using derivative products are but an example. The SEC needs to focus more attention on its real competency so that it is not seen as merely tagging along with the criminal authorities at best or completely overshadowed at worst.

Joan McKown is a partner in Jones Day’s Washington, D.C. office. She specializes in securities litigation and SEC enforcement defense. Prior to joining Jones Day in October 2010 she was the long time chief counsel in the SEC’s Division of Enforcement where she played a key role in establishing enforcement policies and in reviewing all enforcement actions before they were recommended to the Commission.  

The views set forth herein are the personal views of the author and do not necessarily reflect those of the law firm with which she is associated.  


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